An MBO - are you ready for the next step?

There’s plenty of capital around, as private equity houses have an abundance of cash looking for a home and debt providers have loosened the purse strings.

This means now is as good a time as any since the pre-recession years for management teams to explore a buy-out of their business, and they’ve been taking advantage of these opportunities – in 2014 the UK saw 400 Management buy-outs, up 9% on 2013 and the highest since 2010.

So what should teams have in mind as they think about a buy-out?

Timing is everything

While the external financing climate is supportive, the timing also needs to be right for the potential sellers.

The existing shareholders need to be ready to step away altogether operationally. It is an emotional experience for an owner manager handing over responsibility for – and ownership of – something they may have spent decades building from scratch, but there is a right time for everyone. With the decision to sell a must so come the recognition that, while a buy-out should be able to deliver a seasonable price, it may not compete with the sort of value that a strategic buyer might justify. There must be a tacit understanding with the seller that an MBO is an attractive solution for them other than maximising value.

Jockeys not horses

Ultimately it’s the M in MBO that makes it happen. Private equity investors will freely admit that they back management teams, not companies, and this means the team itself needs to be ready for a transaction. It needs to have a clear plan for growth, and the skills and experience to execute it. The team must be reasonably complete, and to have identified in advance gaps which a new investor might help fill.

The team has to be committed and ambitious, ready to work extremely hard to execute the strategy and deliver the plan – the demands of the process are unfortunately only the beginning, and it’s only once the deal is done that the real work starts.

What’s in it for me?

But the rewards can be spectacular. There is no doubt that working to a three to five year financial exit, with your own money on the line, will be stressful at times, but the potential returns dwarf almost anything else you can do with your hard-earned cash…and you will need to have invested some of that too!

In particular, it’s ‘sweet equity’ – the ownership stake acquired on disproportionally favourable terms (i.e., at nominal cost) within a typical buy-out capital structure – which creates massive upside for a team which delivers on its plan.

A good corporate finance adviser will help act as a buffer with management’s current employers and maximise a team’s sweet equity ownership, and will help negotiate the qualitative as well as quantitative terms offered by an investor – things like board seats, control rights, consent requirements for major decisions, good leaver/bad leaver and so on.

An MBO is a delicate balancing act of a number of interests and incentives – but done well it can be the perfect resolution for everyone – and for well-placed management teams, the current climate is a very favourable one in which to consider a buy-out.